THE ELASTICITY OF SUBSTITUTION AND ECONOMIC GROWTH RATE: WHAT LINKAGE?

Year 2022, Volume: 8 Issue: 2, 139 - 151, 06.10.2022

Ata Özkaya

Abstract

We reconsider the effect of elasticity of substitution on: income per-capita, growth rate of capital-labor ratio, growth rate of income per-capita, the steady-state capital-labor ratio and the steady-state income per-capita, respectively. We demonstrate that: first, both income per-capita and growth rate of capital-labor ratio are decreasing functions of elasticity of substitution. Second, we find out that an increase in substitution elasticity leads to an increase or a decrease in the growth rate of income per-capita depending on initial-terminal conditions of the production function. Moreover, we demonstrate that at steady-state an increase in elasticity of substitution decreases both growth rate of capital-labor ratio and growth rate of income per- capita. Finally, we revise the erroneous result that there is a threshold of elasticity of substitution for which there is no steady-state equilibrium and for which ever-sustained growth is entailed. Instead, as a policy instrument increasing the minimum marginal product of labor is demonstrated to increase the growth rate of income per-capita.

Keywords

Economic Growth, Constant Elasticity of Substitution, Production Function, Dynamical Equilibrium, Steady-State Growth Rate

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